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Amazon Effect Impacts Inflation Dynamics

Every year, the Federal Reserve Bank of Kansas City holds a symposium that is participated by prominent central bankers, finance ministers, academics, and financial market participants from around the world. The 2018 Economic Symposium took place on August 23rd – 25th 2018 with the theme "Changing Market Structure and Implications for Monetary Policy". At the symposium, Alberto Cavallo, Professor at Harvard Business School, presented his paper about the investigation of how prices are influenced by the largest online retailer, Amazon.

Cavallo's main finding is that the competition initiated by Amazon has caused a greater frequency of price changes than traditional retailers such as Walmart. Because Amazon covers a wide and large scale of market, it has a very strong influence on the marketplace. The name ‘Amazon Effect’ is an acknowledgment of Amazon's initial and sustainable dominance in online sales. This domination results in disruption in the retail market as customers are more likely to buy goods online rather than going to the physical store.

On his paper, Cavallo revealed that the cause of the ‘Amazon Effect’ could occur is due to the algorithms that caused prices to continue to fluctuate. Suppose that if an item has a lot of demand from buyers, the price of that item becomes more expensive, then other retailers will automatically follow that price because of their tendency look up at the dominant party. In this case, this phenomenon has been broadly replicated, leading to a high level of price uniformity throughout the country.

In other words, Amazon has created a space, with precise, rapid swings in prices, which is not always related to the general factors of supply and demand. Cavallo also showed that from 2008 to 2017, the average duration of price changes of goods sold at large U.S. retailers like Walmart fell from about 6.5 months to about 3.7 months as online purchases contributed for an ever-growing share of total retail sales.

The ‘Amazon Effect’ is the impact the digital marketplace has on the traditional business model regarding consumer expectations and the new competitive landscape. The idea that sellers cannot change prices immediately in response to changes in supply and demand is exactly what gives interest rates in the mainstream model to have an effect on the economy as a whole.